There was some discussion here yesterday on the relationship between tax and government spending. As I pointed I out, this is by no means a direct relationship: the reality is that tax does not fund government spending, all of which can in principle be funded by ‘money printing’ or borrowing.

It is, of course, very unlikely that this would actually happen: inflation would rapidly destroy the value of a currency in this situation and the willingness of people to lend would quickly expire. This means that tax, which is used to balance the equation between government spending, money creation and borrowing, is an essential fact of economic life. The relationship can be formally summarised as:

G = T + ∆B + ∆M

Where:

G = Government spending

T = Net tax receipts

B = Borrowing (and so ∆B is the change in borrowing in a period)

M = Government created money (and so ∆M is the change in that sum during a period).

In this context the purpose of tax is to achieve a number of goals, none directly related to spending:

Reclaiming the money the government has spent into the economy. As already noted, it may appear that tax revenue is being used to pay for government services supplied but that is not true: government spending always comes out of funds the government borrows from its central bank. Tax, in that case, reclaims the money spent to prevent excessive inflation. The amount reclaimed is that which is considered sufficient to leave the desired rate of inflation in the economy.

Ratifying the value of money. Because a government requires that tax be paid using the currency that it creates (simply because that’s the currency it bills in) that currency has for all practical purposes to be used in the economy for which it is responsible, assuming that tax forms a significant part of people's total liabilities. The payment of tax does, therefore, give a currency its value in exchange and as a result passes control of an economy to the government that charges that tax. This makes tax an absolutely fundamental component in macroeconomic policy.

Reorganising the economy. Fiscal and monetary policy are the two fundamental tools available to a government to manage its economy, assuming it has its own currency. As the explanation already offered has shown, money creation and taxation are the flip side of each other. Tax is then an integral part of macroeconomic policy and so of reorganising the economy to meet social and economic goals.

Redistributing income and wealth within the economy. Experience has shown that market economies are very good at concentrating income and wealth in the hands of a few people in a society. At the same time economics makes clear that this is harmful to the prosperity of a society as a whole because it seriously reduces overall levels of demand in the economy. Redistribution of income and wealth is then an essential function that any Government must undertake and appropriately designed taxes are a proven and effective method for delivering this policy.

Repricing goods and services. Markets cannot always price the externalities of the goods and services they supply or reflect social priorities. Tax permits repricing of goods and services to reflect these facts.

Raising representation in a democracy. The fact is that if people know they pay tax they vote. This only seems to be true, however, for income taxes. That's why it is important that people are in that tax system. When they are they want a say on how the system works and democracy is enhanced as a result.

When this is properly understood by governments we might get some decent economic policy. And as the formula shows, it’s not exactly rocket science and yet it is apparently nigh on impossible to get politicians (and others) to accept this reality which is why we perpetually end up with the fascicle question whenver a new poliucy is proposed of ‘how are you going to pay for it?’, which in itself assumes that the above variables are independent of each other, when they are not. But that’s the subject of another blog.

77 Responses

Again, its that good old neo-liberal reductionism as identified by Steve Keen that leads to the decoupling of these inter-acting variables.

Point 6 stands out for me.

What if in the expression of their democracy the people decide they do not want to be taxed anymore?

It seems to me that such a sentiment can begin to form if you have Government filled with such people (neo-lib Tories, Orange Book Lib-Dems and Blue Labour) they can manipulate public opinion to make it look like the tax system does not work. Or you tell people that they are taxed too much (look at America).

It also reminds me that an assault on the tax system is truly anti-democratic.

And that we do indeed have ‘anti-democratists’ at the heart of our democracy.

If we are going to use the term ‘fascism’ we could also replace it with communism (soviet style of course). And in keeping with your stated heterodox approach I would suggest using the term fascism is a tad orthodox. (I cannot put a smiley here but I would if I could).

If I may state this:

If we are to reframe things, two areas we need to look at are these (no doubt there are others but just humour me a while):

Inequality – should now be ‘unfairness’

Fascism – should now be ‘anti democracy’

I offer these alternative terms as a means of reaching more people. People accept inequality because they know that everyone is not the same. People think the use of the word ‘fascist’ is something used by the Left or those who have gone to college. Or is it to do with some bloke called Adolf whom we defeated anyway? It seems a bit old hat.

You know – I could be wrong – but I am just trying to reach out here in a world which no longer values experts to instead use language that resonates with people who are too busy playing with apps, working through TV series boxed sets and whom now think that English is written in the way that we text each other.

And let us also think about how the Right have used the concept of ‘unfairness’. It is a very powerful concept and has been misused in an attack on the most vulnerable in our society. Well, let us progressives use it too I say. Let’s turn the tables on the undemocratic swine that the Right truly are.

Pilgrim – you are spot on. I suspect you’ve been keeping track of Mr Lakoff…. Framing is hugely important and seems to be understood by very few on the left. Lakoff has been pointing out for years how the right has reframed language with tax being a specific example.

Both Anti-democracy (as opposed to fascism) and Unfairness (as opposed to inequality) work very well for me. Both are fairly un-political and should tap into deeper emotions. The challenge then is to get terms like these into as widespread use as possible. If those reading these blogs like them, how about we all start using them?

“….What if in the expression of their democracy the people decide they do not want to be taxed anymore?…..”

Wait and see. That is the current situation we have and which government is not challenging.

The right wing ‘all tax is bad’, ‘all state spending is bad’ , ‘all government intervention is manipulative’ (read bad), …..all this ‘thinking’ is predicated on a belief that tax is bad, tantamount to theft of private wealth by the state for its own nefarious purposes. So we don’t want to pay it. At best you will hear a grudging admission that some taxation is a necessary evil as in the two certainties: death and taxes.

This is the neoliberal narrative. Which is why I refer to it from time to time as ‘paleo-conservative’, because that’s what it is. Calling it neoliberal was a clever ‘marketing’ exercise in making it sound centrist.

It’s amazing how many supposedly educated people you can fool for how much of the time.

My view is that THIS GOVERMENT is promoting tax as a negative thing – never mind challenging this notion. Look at HMRC’s lamentable performance?

The days of using tax as a political football need to end now. The result is that all I see these days is things falling apart. Some might call this change but I do not accept it on that basis. This is not change. It is destruction.

Perhaps we should try educating journalists to ask the right question- e.g. why are you, Government, not providing adequate cash for the NHS? This would possibly make the ignorant politician say “there is no money” and then the journalist could counter the answer- and thus help educate the population instead of continuing the politicians myths.
Can you offer free seminars to the BBC news and Today journalists and Daily Mail?

Many prominent media figures work for multi-billionaire capitalists who aren’t keen on paying taxes. Any lack of enthusiasm for asking these kind of questions is most probably directed rather than through ignorance. What else might we expect?

We all know the equation. It assumes a closed economy. We have a sovereign currency and have the opportunity to borrow or print / create money as well as raise taxes. But the decision isn’t entirely in our own hands as we are dependent upon the international community for trade and to raise borrowings. This is key. The FX markets are an international exchange which, to a large extent, prices the goods and services we buy and sell. The greater the reliance on borrowing and money creation the weaker the currency will become? Is that agreed? If so given the inelasticity of many goods (oil etc) then inflation kicks in. This might be over a long term (look at the US and its debt) or over the short term (in the UK post the referendum result).
So there is no magic money tree, the FX markets won’t allow it.

Of course FX is an issue but let’s get matters into perspective. First, FX dealing comes in two parts. One is real: it relates to trade. The other is speculative.

Now, of course there are some FX issues that are external e.g. commodity prices. They have an impact. So too do things like Brexit: international relations are an issue. But both are because they impact real trade prices. And as we know, markets adjust for them. They take time, but they do.

Of course there are issues if states run long term deficits: the UK is. but we attract inward investment still and we have significant overseas earnings, as the BoE noted recently, and gains, that compensate the deficit. You ignore that.

You also ignore that if a government were to run a deficit on its account then that would logically be to increase productivity overall: that would counterbalance the trade deficit issue. So in fact it would always in the long term (which is anything much beyond a week in these terms) keep the FX market happy by doing that: quite simply more economic activity which is what government deficit funding involves keeps them happy.

And re borrowing? Have you not noticed QE? Have you noticed that it it real? Have you noticed markets objecting? Have you noticed them not allowing it? No, of course you have not. They love it. why? Because it keeps debt in short supply and prices high and that’s just what they want. And that’s what it will do.

So if there was an FX challenge now what would the government do? A Black Wednesday hike or buy £100 bn of debt? You know the answer to that. FX is powerless to speculate against this.

I am sorry, but you are talking nonsense in the case of governments with their own currencies, significant trade and who issue debt in their own currencies. They’re not small open economies as you would like to think them. They are anything but. I suggest you get out of your failed theory and look at the real world.

1) a deficit on its current account leads to productivity gain – really!!
2) QE is fascinating. In its current guise (suppressing long dated gilt and corporate bond yields ) it has probably succeeded as we didn’t have deflation. The problem is unwinding it. Going forward Issuing gilts to conventional investors will come at a higher cost as without “manipulation” (QE) they will offer negative real rates of return. So interest rates – by that i mean medium and long dated interest rates are heading higher. The alternative is upon maturity just reissue gilts to ourself – this is effectively “peoples QE”. This will be a massive concern to FX markets and sterling would get smashed and giving us an inflationary problem in the process.
3) Yes we do attract inward investment but would we if we taxed more and printed more? I dont think we would.

a) Of course deficits have to be used wisely. If not – as for example as at present, then there are issues

b) QE need never be unwound. why would you want to destroy the money the economy needs to function? And you know what? If FX markets don;t like it, who cares? Since, as Japan near enough now proves, we do not actually need to issue debt so what if they do not like it? You’re just huffing because you know that is true.

c) Investors always like economic activity: government delivers that better than anyone else

I am not sure that your point is that it is just income tax that informs democracy – it is visible tax. In the UK that is most obviously income tax; VAT is hidden in inclusive prices. In North America, where sales tax is added, this is very visible and therefore becomes part of the ‘tax dollars’ concept. We saw the same with the Poll Tax in the 1990s.

Laurence says:
January 3 2018 at 10:09 am
“……We saw the same with the Poll Tax in the 1990s.”

What we saw with the ‘Poll Tax’ was blatant attempt to shift the burden of local taxation onto the people least able to pay it. There was some very warped logic behind it and Heseltine’s Council tax didn’t nearly restore the balance and no government since has dared to touch it.

I agree with you Richard – the bogeyman is this view that FX will not allow it and that Governments are powerless. This is a con.

Of course the FX won’t. They will object but all that needs to happen is for Governments to take back control of these systems from those to whom they have been ceding power all too willingly.

And when I say take back power – I do not mean in the sense of a creating a completely planned economy – I’m talking about more balance between state and market and a pro-active role for Government in a social market style economy which has the potential to make capitalism work better – which is to redistribute wealth more fairly than it is now.

We should at least try. The issue I have with DC is that we know things are not working yet he/she seems to accept that? Why is that? Shouldn’t we do something about it and ask why the FX want things to stay as they are? Especially after 2008.

Because we have now seen the money creating power (or just ‘ the power’) of Government. Let’s see some more power from Governments concerning exchange controls for example and other areas where they still need to bring the financial markets under control. Because whether it is FX or oil futures or whatever, we now know the markets can be wrong.

Markets and Governments are not infallible (whereas before 2008 in particular the wisdom of markets was sacrosanct) . So why not accept that and work together. Let’s just have a better mix of powers and opportunities for both.

Yes Japan, US, UK and the EU use QE. And yes capital markets have notionally warmed to QE as money flooding a (relatively) stable pool of assets obviously forces prices higher. This doesnt mean we are not storing up problems for the future. I think we are.

Obviously there are a billion articles on the subject. This bloke is not an academic but a real world practitioner. You may think he stands for all the excesses of the western world but really he understands how the system works better than pretty much anyone. In fact Richard he is much closer to you in his ideals than it may seem- massive critic of QE and the inequality it creates.

The formula (slightly rearranged): G-T = (change in)B + (change in) M is really just a representation of how the accounting works. I’m not sure it’s ‘an essential fact of economic life’ unless you mean by ‘ an essential fact of economic life’ that ‘that’s the way we do it with present arrangements’ which is true.

G-T being equal to ‘the change in bonds + the change in high powered money ‘ is the system we have now but we don’t really need the bond bit as we’ve discussed before, that’s just a convention of the system rather than an unchangeable law of nature and a hang over from gold-standard thinking. There are other ways of regulating interest rates without the to-ing and fro-ing of bonds.

The bond bit is the Government creating an asset (form of money) out of nowhere and exchanging it for a more liquid form of money -why go through this farce? Kalecki has an interesting take on this:

‘It may be asked where the public will get the money to lend to the government if they do not curtail their investment and consumption. To understand this process it is best, I think, to imagine for a moment that the government pays its suppliers in government securities. The suppliers will, in general, not retain these securities but put them into circulation while buying other goods and services, and so on, until finally these securities will reach persons or firms which retain them as interest-yielding assets. In any period of time the total increase in government securities in the possession (transitory or final) of persons and firms will be equal to the goods and services sold to the government. Thus what the economy lends to the government are goods and services whose production is ‘financed’ by government securities.’

So the whole thing is a bizarre ‘wiggle-dance.’ And, in a way, it lacks transparency because it hides the fact that the ‘borrowing’ isn’t anything of the sort, it’s just an asset swap (bonds for cash)- when you swap something, it’s not borrowing. So the use of this language reinforces TINA type thinking, it seems to me. So the formula should be:

“Tax, in that case, reclaims the money spent to prevent excessive inflation. The amount reclaimed is that which is considered sufficient to leave the desired rate of inflation in the economy.”

We have been repeatedly told that the government/BofE is dismayed by the non-appearance of the ‘expected’ increase in inflation which they thought QE would produce.

Early criticism of QE maintained that this unprecedented level of ‘money printing’ would be sure to produce rampant inflation.

I would argue that that is exactly what it has done. But the monetary authorities are only measuring inflation in the lower end of the economy (wages and shopping baskets)and ignoring rampant inflation in top-end remuneration and vast inflation in asset prices. (Much of the property price inflation is masked by the fact that after 2008 prices did not ‘correct’ as they would normally have been expected to.)

Presumably there is some expectation that inflation will ‘trickle down’ since as we all know wealth doesn’t.

The rational response to reclaim QE injection surely has to be to tax it out of the top end of the economy where it is still sitting?

Pilgrim – exchange controls have a history of having the reverse effect of what they intend.

The crux of Richards argument is whether the FX market can adjust to the continuous creation of money. Intuitively i really think FX markets can only react in one way, both short and long term, unless the policy was universally adopted across the board. I agree with Richard that real trade and the hedging of real trade ultimately dictates the setting of prices and speculators try to pre-empt this.
A simple scenarios envisage if Britain adopts Peoples QE in isolation. The perception of an “open ended supply of sterling” will force sterling down and the prices of imports up. This includes the price of components for goods we manufacture. This will also fuel wage pressure so the cost of our goods and services are going up…the key word is QE In isolation (by this i mean excessive or much more than our trading partners). Thereafter unquestionably we will export less but the argument goes that the G component will just take up the slack through more QE. Where does this leave us ultimately? I think it leaves us as a near closed economy with a horrible trade deficit, rapidly sliding down the international prosperity tables and we all, both rich and poor, will be worse off.

“The perception of an “open ended supply of sterling” will force sterling down”

a) would this be a rational perception? Why?

b) Did Mario Draghi’s promise to ‘do what it takes’ and Janet Yellen’s prediction of there being no crash expected in her (or some unspecified person’s) lifetime (implicitly because she also would do what it takes) cause their respective currencies to plummet?

There absolutely has to be control on bank lending. That was one of the problems leading up to the crisis in 2008. Look at the growth in the money supply in the 10yrs prior, it was insane and largely into property loans. Creating money out of thin air whether through printing or through the banking system will cause excesses at some point. People’s QE is probably easier for politicians and the electorate to understand and easier to look at the ensuing risk. Whether relevant or not they will point to history for evidence.

I don’t claim to have all the answers but I do understand how excesses and misguided policy can cause damage to the financial system, whether it be LTCM, Russian debt default, the appalling situation in Greece, or the mess Venezuela has found itself in.

The board clearly feels that, all other things equal, an increase in the quanity of sterling either through QE or the banking system will have no effect on the exchange rate – fair enough though many, like I, feel it will.

Final comment (i promise) on QE…one of the greatest beneficiaries of the suppression of the yield curve is owners of a final salary pension scheme. if in the public sector then entirely funded by the taxpayer – as a crude calculation, anyone getting a £25k pension has a pot worth around £1m!! …, curiously public sector final salary pension scheme falls outside the boundaries of your proposed wealth tax?

I would be very interested to see your sources for 6) and the idea that taking people out of income tax reduced their likelihood to vote. It’s always seemed like an interesting topic on which I am keen to read more?

Angus Groom says:
January 4 2018 at 10:14 am
“… taking people out of income tax reduced their likelihood to vote. …”

I don’t have any sources on this at all, but I think it interesting that it may be a logical corollary of the ‘No Taxation without Representation’ argument.

I suspect, but cannot substantiate that Gordon Brown scrapped his then only recently introduced lower 10% income tax band when he twigged that the people he was encouraging to vote were inclined to vote for UKIP not for Labour which was increasingly courting the middle class vote.

For some perverse reason we persist in disregarding NI as part of the discussion on income tax rates.

Richard maybe knows why it makes some form of sense. I regard it as probably a devious ploy to pretend income tax is more progressive than it is in reality.

Today – If i have a pension pot of 1m i can buy an annuity of about £25k a year..if i have a pension of £25k the value of that is therefore £1m ….indeed people in final salary schemes can convert into a lump sum and drawdown themselves – to propose to (wealth) tax defined benefit and defined contribution pension is bizarre.
And i repeat one of the largest beneficiaries of QE (i.e the manipulation of gilt gilts by the BofE) is those with final salary schemes – dont you agree?

A record number of people are doing final salary transfers!!! I.e exchanging their future pension cash flows for a lump sum today and giving their pension pot to someone to manage.. they are doing so because the present value of their future guaranteed cash flows have ballooned through QE..It is a real value, as it is for someone having to a defined contribution pension having to pay £1m to get a pension of 25k pa. QE has hammered them.

No QE has created imbalances and inequality all over the place.
With Pensions:
The losers = people retiring and buying an annuity in recent years and future generations being denied final salary schemes as they are too expensive to run
The winners = people lucky enough to have a final salary scheme, particularly those approaching retirement.http://www.rosaltmann.com/ceri_radford_comment_qe_mar09.htm

QE in its current guise morphs into “Peoples QE” when gilts mature and are reissued to ourself. They are ultimately the same thing and the consequences are the same. Interests rates are suppressed and the value of money is devalued and we are creating problems further down the road, many we are not even thought of.

On maturity Gilts are reissued in the conventional sense to investors ( pension funds, asset managers etc) at market interest rates where the supply is met by demand and the GRY is set accordingly..lets say PRE QE a 15yr new reissued (or new gilt ) was issued at a 6% coupon. The gilts then trade freely on the secondary market – post QE the Gilts are purchased by the Bank of England at massively inflated prices so virtually every rational institution sells (long dated yields yield around 1.5% !!!!!). So now the Bof E own the issue – this is conventional QE suppressing market interest rates and the BofE replacing conventional investors as owners. When these Gilts mature and the Government has a shortfall they can choose to reissue back to themselves at the suppressed GRY or can sell to conventional institutions who would demand a much higher rate of return – is is now too expensive.
SO THE Bank of England REISSUE BACK TO THEMSELVES – conventional QE morphs into Peoples QE.

1) read the text, i say gilts were issued at around 6% PRE QE – they were
2) i understand perfectly well what peoples QE is, it is very straightforward – issue Gilts and via a state controlled intermediary (national investment bank for e.g) spend on whatever the Govt likes.
3) Through conventional QE the State takes ownership of Gilts in the secondary market..Through Peoples QE the State takes ownership of Gilts in the primary market. The two morph because ultimately the end game is the State will own the entire National Debt as no rational investors are not going to own Gilts at suppressed interest rates as they are consigned to owning negative real returns)…Unless of course the State forces private ownership in some way!

This isn’t my own thinking or theory – it is how it is! … next time you converse with Joseph Stiglitz (or any sensible economist ) ask him and 100% he will agree!!

dc says:
January 4 2018 at 11:07 pm
“1) read the text, i say gilts were issued at around 6% PRE QE – they were” But that was in a world where we were all pretending we had a functional banking system rather than a casino culture of banks engaging in the biggest pyramid selling scheme the world has ever seen. Effectively playing pass the parcel with bundles of falsely rated derivative bundles.

With respect this is silly. If the government is going to spend on ministerial champagne and caviar parties ….well yes you are probably right. The point however of PQE is that government spending is investment in the infrastructure and services that the country needs in order to function. That’s somewhat different in intent and would be massively different in terms of outcomes.

3) Through conventional QE [……] rational investors are not going to own Gilts at suppressed interest rates as they are consigned to owning negative real returns)…” But they are doing ! Negative yielding bonds are changing hands all over the place aren’t they? And I can only assume investors are buying these because they fear that alternative investments are an even worse bet. Equity prices are wildly inflated above value of the underlying and (in many cases) declining assets. The property market is continuing to run in ethanol and may correct massively or go berserk. Against those sort of risks and uncertainties, negative yield on bonds suddenly looks rational. You seem only to be considering the effect on bond market, and it doesn’t operate in isolation. Far from it. QE reset the banks but it didn’t restore the staus quo ante. And ‘unwinding’ it won’t put it back together again. (Careless unwinding would collapse the entire edifice) if you want to think nostalgically of 6% bond yields you might just aswell consider running barefoot through wheat fields with Theresa May. (As LP Hartley put it: That was the past; they do things differently there.)

“This isn’t my own thinking or theory – it is how it is! … next time you converse with Joseph Stiglitz (or any sensible economist ) ask him and 100% he will agree!!” I can’t speak for Richard’s agreement with Stiglitz, but I have to say I’m deeply sceptical about the pronouncements and pontifications of an economist who is prepared to base his assumptions on the US Government claim that the US economy is at or close to ‘full employment’ when a fifth of its workforce is un- or under-employed in the mainstream economy.

When are these ‘sensible economists’ ( who are they? where are they?) going to twig that the neoliberal experiment has actually collapsed as it inevitably has to because it’s based on nonsense, and a new understanding of the economy has to be forged which will work.

Don’t worry about bond markets they’ll sort themselves out. All Treasury paper is worthless without a viable government to back it.

Ultimately when the excrement hits the extractor and the FX markets are causing havoc a viable government would just shut down the exchange. Money belongs to the government and the government is allowed to decide who can play with it.

If the ‘Market’ is not going to play nicely the market will be sent to the naughty step and its toys will go back in the cupboard. In the meantime, if you, DC are a player, forget fundamental analysis and just play close attention to the charts.

I respect your knowledge on many things particularly tax evasion and I share your motivation for reducing inequality.
With regards to macroeconomics you are flawed (in my humble opinion). The global financial crisis is a separate issue, why throw it in.

I am trying to envisage money created without it being debt. It seems to me it’s limiting money creation to interest-bearing debt which is creating the problems we have and will continue to have about growth; this system always demands it extracts more than it puts in. Hence the ceaseless demand for that growth. Our scope for growth, however, is finite as we have the wealth of just the one planet to hand over to the banks. Sooner or later this system will crash then. That given, I’d prefer to see this system abandoned sooner rather than later, while we still have some planet left to leave to our descendants. With that in mind, could not money be created sans interest with some form of demurrage being implemented to control inflation? I’m thinking Worgl here… again!

You’re losing me there so, slowly… when you say cash, you mean it in the old sense; coins, yes? Not notes? I sometimes forget you speak accountant and not the language the rest of us do. I only found out cash used to mean gold/silver coinage and excluded bank notes when I was researching Dutch Finance.